Streetwise Professor

August 22, 2009

Sergeant Schultz Sees Something!

Filed under: Derivatives,Economics — The Professor @ 5:35 pm

About 10 months ago I wrote about a massive squeeze on VW stock, associated with the revelation that Porsche had accumulated an immense options position on the larger company’s stock. For a brief time, the squeeze made VW the largest capitalization firm in the world.  The only comparable event in historical record that I am aware of is the Northern Pacific corner of 1901.

The German financial regulator, Bafin, investigated.  But, apparently channeling its inner Sergeant Schultz, it concluded: “I see nuthink!  I know nuthink!”  Disregarding the obvious evidence of a massive manipulation floating before it very eyes, Bafin declined to proceed against Porsche, stating  “We didn’t find any indications for a share manipulation.”  I am speechless.  No indications?  Did you, like, you know, look at the stock chart?  Just what exactly caused that massive spike in price?  That is all, Sergeant.

But, apparently either Sergeant Schultz was sent to the Eastern Front at long last and replaced by a more vigilant overseer, or the threat to do so finally caused him to open his eyes.  For German prosecutors, acting on a referral from Bafin, dramatically raided former Porsche CEO Wendelin Wiedeking’s home, and the home of Porsche’s former CEO:

German prosecutors are investigating Wendelin Wiedeking, Porsche’s former chief executive, and other people close to the sports car maker, alleging market manipulation and the leaking of inside information in the failed takeover attempt of Volkswagen.

Prosecutors in Stuttgart yesterday raided the headquarters of Porsche, which recently agreed to merge with VW after an attempt to acquire the much bigger rival had pushed it to the brink of bankruptcy.

. . . .

Claudia Krauth, a prosecutor at the regional court in Stuttgart, said the investigation had been launched after a complaint from Bafin, Germany’s financial regulator.

Bafin launched an investigation into market manipulation this year after a German press report suggested that Porsche had misled markets about its ambition to take over VW.

Actually, changes in political fortunes are the best explanation for Bafin’s change of heart.  Porsche’s wild gambit failed this summer, resulting in the acquisition of the company by VW, and the ouster of its CEO  Wendelin Wiedeking.  When Wiedeking was riding high, and was still a power in Germany, Bafin had little appetite to take him on:

Last month, VW’s shares rocketed after Porsche unexpectedly disclosed that through the use of derivatives it had increased its stake in VW from 35 to 74.1 per cent, prompting Bafin, Germany’s financial regulator, to launch a formal investigation into possible market manipulation.

But analysts blamed Bafin for allowing Porsche’s use of options to secure secretly a dominating stake in VW.

Investment bankers said Bafin felt little appetite for pursuing an investigation of Porsche as it lacked political support for such a move. [Emphasis added.]

So, Wiedeking is on top–no manipulation.  Wiedeking is down:  Into the cooler!

I guess late is better than never, but this correlation between Wiedeking’s power and the posture of German regulators and prosecutors is unseemly, to put it mildly. There can be little new information about the squeeze itself that would explain the timing; Wiedeking’s precipitous fall seems the most salient development.  It hardly inspires confidence in Bafin’s independence and probity to observe this pattern of conduct.  It strongly suggests that financial regulators in Germany are captured by those whom it is supposed to regulate.  Not that this phenomenon is limited to Germany, but on its face this is a particularly egregious example.

August 20, 2009

No Green Shoots on the Steepes

Filed under: Economics,Financial crisis,Politics,Russia — The Professor @ 9:49 pm

Although there are fleeting, ambiguous signs of recovery in the US, Germany, and France, conditions are far more bleak in Japan–and Russia.  Russian retail sales continued their steep fall:

Russian  retail sales dropped the most in almost ten yeas in July, sliding for a sixth consecutive month, as households cut back spending after incomes dropped and consumer borrowing declined.

Sales slid 8.2 percent from a year earlier after declining 6.5 percent in June, theFederal Statistics Service said in an e-mailed statement from Moscow today. That was more than the median  forecast of 16 economists surveyed by Bloomberg for a 7.1 percent drop.

. . . .

Retail sales began slipping in February for the first time since September 1999 as the weaker ruble, wage cuts and rising unemployment forced Russians to curb spending. The central bank’s five interest-rate cuts since April 24 have failed to spur lending as banks hold back on concern borrowers can’t repay loans. Lending to consumers dropped 1.1 percent in June for the fifth consecutive monthly decline, according to Bank Rossii.

Gross domestic product contracted a record 10.9 percent in the second quarter after shrinking 9.8 percent in the first three months, ending 10 years of expansion that averaged almost 7 percent. Average wages rose six-fold in the past decade as the economy recovered from the debt default and ruble devaluation of 1998.

. . . .

The average monthly wage fell an annual 5.8 percent in July, while real disposable incomes decreased 5.4 percent.

Capital investment tumbled 18.9 percent as industrial output declined an annual 10.8 percent in July.

Given all this gloomy news–which is far more gloomy than from developed markets (even Japan, which showed growth last quarter), and far, far more gloomy than from any emerging market–this bit is extremely anomalous: “Russia’s  unemployment rate remained unchanged at 8.3 percent in July.”  This calls into question the government statistics.  Or, if the government statistics are in fact correct, it means that there is considerable hidden unemployment; that firms (most likely due to government pressure) are not laying off people, but are keeping them on and paying them (mostly) even though they are not productive.  This eases social pressures in the short run, but eats into the already shaky financial foundations of Russian firms, and thus further undermines Russia’s dodgy banking system.  This will delay and weaken any recovery.

Russia faces extreme difficulties.  Its political brittleness, and the rigidity of its labor market (due in large part to the monocities, the legal and institutional nihilism and state capitalism that stifle small business and encourage large, cumbersome enterprise, and other Soviet inheritances) make it very difficult to adjust to large economic shocks; in this system, large enterprises serve as welfare agencies.  But this threatens to turn them into zombies–and take the rest of the Russian economy with it.

Cling Ons

Filed under: Politics,Russia — The Professor @ 9:15 pm

Philip Stephens gets it mostly right about Russia in today’s FT. He correctly notes that Russia is friendless, except for an odd assortment of international pariahs.  He is right that this reflects the facts that (a) Russia’s all gall no sugar approach of bullying, extortion, and threats is off-putting in the extreme, and (b) Russia’s socio-political-economic model is repulsive, rather than attractive.  This line is particularly wicked, and particularly on point: “To put it another way, what country in the world wants to be more like Russia? I cannot think of a shorter list.”  To which I might offer: Cubs post-war World Series Championships (unless the War in question is the Spanish-American).

Where Stephens is very likely wrong, in my view, is not his diagnosis of the present or the past, but his predictions for the future:

Moscow will discover eventually the limitations of its capacity to obstruct. It is starving itself of foreign technology and investment. Making life difficult for the west is not the same as shaping a different international landscape. Even those who now pay notional fealty to Moscow are hedging their bets with China or the west. . . .  To quote the plain-speaking Mr Biden, it is hard when you lose an empire, but you cannot cling on to the past indefinitely.

Since when has Russia discovered the limitations of obstruction?  Indeed, it is more reasonable to conclude that, based on Russian behavior, the more its conduct alienates others; the more isolated it becomes; the more pronounced its sense of victimization becomes, and the more contrary and aggressive it becomes.

Since when has the prospect of obtaining foreign technology and investment led it to restrain its pugnacity?  The dynamic of the natural state actually makes it virtually impossible to restrain its expropriations of foreign investors, and further makes it unwilling to accept the unsettling consequences of economic openness.

No, Russia will not discover the limitations of obstreperousness and obstruction.  A pernicious feedback cycle reinforces its behavior.  The past and present are prologue.  Russia will not just cling to its past; it will continue to rush headlong to embrace it.

Still Hacked Off

Filed under: Military,Politics,Russia — The Professor @ 8:50 pm

An executive summary of the report on the Russian cyber attack on Georgia is now available online.  The summary provides additional detail about the preplanning of the attack, the coordination between the hackers and the Russian military and/or government, and the role of organized crime.

Some details.  Regarding preplanning and coordination with the military:

Many of the cyber attacks were so close in time to the corresponding military operations that there had to be close cooperation between people in the Russian military and the civilian cyber hackers. . . . Given the speed of action, the signal to go ahead also had to have been sent before the the news media and the general public were aware of what was happening militarily.

Regarding the participation of Russian organized crime:

Some of the webservers and addresses used to control and coordinate the attacks were ones that had been previously used by Russian criminal organizations. . . . specific botnets employed in the cybercampaign were ones closely associated with Russian organized crime.

. . . .

The first wave of cyber attacks was carried out by botnets and command and control systems that were ready before the Russian invasion.  These were the botnets and the command and control systems associated with Russian organized crime.  They were the only botnets known to be utilized in the cyber campaign. [Emphasis added.]

This contradicts commentor S/O’s assertion on the original post that the big botnets came later, and the freelancer attacks came first.  Rather, the big Russian mafia botnets came first, and then freelancers coordinating and communicating via social networking sites jumped on the bandwagon after the fact of the war became publicly known.  It further supports the view that the Russian military explicitly cooperated with Russian organized crime as part of a full-spectrum military campaign against Georgia.  It is an important piece of evidence that bolsters the already strong circumstantial case that the invasion of Georgia was anything but a response to a Georgian assault on Tskhinvali.

This is further supported by the report’s conclusion that “[t]he primary objective of the cyber campaign was to support the Russian invasion of Georgia, and the cyber attacks fit neatly into the invasion plan. . . . The cyber attacks significantly impeded the ability of the Georgian government to deal with the Russian invasion.”

And finally, it all comes down to energy.  Doesn’t it always with this crowd?:

If the campaign is seen from a broader perspective, encompassing economic and cyber action, the real strategic focus seems to have been the Georgian oil and gas pipelines.

The attack was preplanned (indeed, the report documents that at least a portion of the attack had been prepared in 2006); it was launched almost simultaneously with the Russian military attack, and before news of the outbreak of fighting was publicly known; and it was designed to paralyze the Georgian government, military, and economy.  Again, like other aspects of the campaign, it is virtually impossible to claim that it was a merely impromptu response to a reckless Georgian attack on Tskhinvali.

I say again.  The Russo-Georgian War happened because Russia wanted it to happen.  It was a war of choice.

Two Out of Three is Very Bad

Filed under: Financial crisis,Politics — The Professor @ 2:45 pm

“Cash for clunkers” is apparently predicated on two of the three most common lies:

  • “The check is in the mail.”
  • “I’m from the government, and I’m here to help you.”

Heaven help us.

August 19, 2009

Condemned to Repeat It (?)

Filed under: Military,Politics,Russia — The Professor @ 9:23 pm

The debate over the culpability over the Russo-Georgian War focuses on the events of August 7-8.   Although these events are important, and many, including yours truly, have analyzed them in some depth, I have also emphasized that a full accounting cannot be based on these days alone.  Instead, it is essential to consider the events leading up to the commencement of hostilities, going back some years.

A new book, The Guns of August 2008: Russia’s War in Georgia, does just that, and makes it clear that the watershed date is 1999–the time of Putin’s ascension to the premiership.  That change in government marked the beginning of escalating Russian pressure on Georgia.  In particular, the chapter by Andrei Illarionov lays out in precise, chronological order, the ratcheting of coercive measures and provocations that ultimately culminated in war.  Illiaronov makes a compelling case that a combination of imperial ambitions and personal animus and resentment (especially within the Russian military) drove Russia to take hostile actions against Georgia, very few of which were met by Georgian reprisal or reaction in kind.  Russia did not like Georgian independence.  They did not like it under Shevardnadze (whom most Russians blamed for the breakup of the USSR).  They liked it even less under Saakashvili.  They were determined to cut Georgia down to size–whoever led it.  The arming of the South Ossetians and Abkhazians (the armaments provided the former, says Illiarionov, were worth 150 percent of the province’s GDP!), the support and promotion of the most extreme leaders (especially in South Ossetia), aggressive espionage, economic sabotage (especially of energy infrastructure), the withdrawal from the CFE treaty, the abrogation of CIS sanctions regarding Abkhazia, the violations of Georgian airspace (including attacks on Georgian facilities), the shootdowns of reconnaissance drones, the deployment of regular forces to Abkhazia, the repair of the Abkhazia-S. Ossetia rail link, and on and on and on, all point to a long term strategy of destroying Georgian independence. Given all of these developments, if the war hadn’t begun on 7-8 August, 2008, it was only a matter of time–and very little time at that–before it did.

Iliaronov and Pavel Felgenhauer also provide considerable evidence supporting the proposition that the Russians planned an attack and initiated the hostilities in August 2008.  I’ve stated repeatedly that even if Russian troops did not enter the Roki Tunnel before Georgia opened up with its artillery on Tskhinvali, they could not have arrived on the South Ossetian capital’s outskirts even on the mid-afternoon of 8 August if they were not in movement order, waiting to implement orders to advance issued well before 7 August. Illiaronov and Felgenhauer provide much additional circumstantial evidence that an attack was already in the works when the Georgian guns opened fire and their missiles flew.  Of particular interest to me were the disclosures that: the Northern Caucasus Military District leadership deployed to Java on 6 August; the leadership of the Leningrad Military District (!) deployed to the lower Kodori Gorge in Abkhazia on the same date; on that date as well all shops and offices in Tskhinvali were closed, and the evacuation of civilians accelerated; and the Russian Deputy Defense Minister, the Deputy Chief of Military Intelligence, and the Commander of the 58th Army met with the Ossetian leadership in Tskhinvali on 2 August.  All of this is consistent with the implementation of a plan to engage in hostilities.  The well-known presence of 50 Russian journalists in the days before the battle began also suggests that something was underway already well before Georgia acted.

To this, add something not in the book; the hacking story I wrote about a few days back.  The Telegraph has more details:

A report by the United States Cyber Consequences Unit claims that last year’s cyber attacks on Georgian websites were carried out by independent groups of civilian hackers with a special relationship to the Russian government.

“Many of the cyber attacks were so close in time to the corresponding military operations that there had to be close co-operation between people in the Russian military and the civilian cyber attackers,” the report said. “Many of the actions the attackers carried out, such as registering new domain names and putting up new websites, were accomplished so quickly that all of the steps had to have been prepared earlier.

“Given the speed of action, the signal to go ahead also had to have been sent before the news media and general public were aware of what was happening militarily.”

This provides further evidence of advance planning, involving all elements of the Russian security apparatus–including its criminal branches.

The escalation of Ossetian artillery fire on 28 July, which touched off the spiral to war, must also be laid directly at Russian feet.  (For those oh-so-sympathetic to Russian “peacekeepers” and Ossetian civilians, note that on that date the Ossetians opened fire on OSCE peacekeepers–note the lack of quotation marks there–and “villages with mixed populations under Georgian control.)  Why is this a Russian responsibility?  Because members of the Russian force structures held all of the ministerial positions in the South Ossetian security structures.  Thus, the Ossetian military was Ossetian in name only; it was under Russian command.

Felgenhauer addresses some issues that exercised me during the short war and its immediate aftermath, most notably the failure of Georgia to bypass Tskhinvali and make a more robust effort to block the Roki Tunnel.  He states that the Georgians misread Russian intentions to launch a full-scale assault, and their intelligence failed to grasp the size and strength of the Russian force.  As a result, although it did attempt to bypass Tskhinvali for the most part, and did make an attempt to seal the tunnel, its forces were inadequate for the task. According to Felgenhauer, the Georgians now state that if they had known Russian strength, and the Russian’s intention to attack into Georgia, they would have prepared a static defense around Gori and Tblisi.

The most depressing chapter of the book is Steve Blank’s.  He analyzes the actions of the EU and the US in the lead up to the war, and during its aftermath.  It does not make for comfortable reading.  Blank is justly scornful of both.  Blank makes a compelling case that the EU seemed to be making a concerted effort to make Neville Chamberlain look good by comparison.  It misread Russian intentions, and with the United States, did enough to encourage Georgia to pursue deeper ties with the West to enrage Russia, but didn’t provide the support it needed to deter Russia or to help Georgia withstand the pressure.  The worst of both worlds, in other words.

The most important errors were the NATO Summit in Bucharest, and the decision to recognize the independence of Kosovo with no regard for its broader implications.  Blank (and David Smith) note that the decision to deny a Membership Action Plan to Georgia actually encouraged Russia to move forward.  In particular, the Europeans, and especially Angela Merkel, stated that no nation could join NATO if it had unresolved territorial issues.  Well, that was an invitation to Russia to make damn sure that Georgia’s territorial issues were never resolved.  The decision to recognize Kosovo was also insanely stupid since it gave Russia the perfect pretext to act as it did.  Hence, given these virtual invitations, it is no surprise that the war broke out mere months later when the weather was optimal and various preparations, most notably the completion of the rail link mentioned above, were complete.  Thus, Angela Merkel and George Bush share much of the blame for the war.

Blank also rightly excoriates the Europeans for their pussillanimity  after the “cease fire.”  The Russians have violated its terms repeatedly, with nary a peep from France (that negotiated the deal) or any other European nation.

Lastly, Blank makes the very excellent point that connects Russian foreign aggressiveness with its institutional weakness:

Beyond exposing neo-imperial cravings, these episodes showed that the undemocratic nature of the relationship between the state and the unreformed defense establishment enabled the latter, along with complicit politicians, to engage in military adventurism without the likelihood of control by the political process.  Not only does such a situation thwart the establishment of democracy in Russia–a principal security goal of the West–but it hinders the stabilization of the post-Soviet world.  When these same Russian neo-imperial cravings were indulged in 2008, the other side produced no effective riposte in spite of ample warnings.

. . . .

Such Russian meddling imperiled the development of more open political institutions in Russia. . . . It also rekindled the notion that Russia had an inborn right to such a sphere of influence. . . . Russia, in short, seeks to freeze the process of European integration and replace it with a regional bipolarity.

And this is the truly scary part.  It appears that the EU and the US have learned nothing from the events of last August, and the nine year prelude to the outbreak of war.  Remarkably, the financial crisis has made Germany and Merkel even more subservient to Russia.  The EU and the US still seem largely oblivious to Russian intentions, and ignorant of the Russian mindset as described by Blank.

This is occurring when the kind of escalation that preceded the Russo-Georgian War is commencing with Ukraine.  The hysterical comments emanating from Moscow, the diplomatic tiffs, the blatantly offensive and undiplomatic letter from Medvedev, all point to a ratcheting of pressure on Kiev.  Now, there is nothing in Ukraine comparable to the frozen conflicts in Georgia, but that does not mean that there are not other tensions that Moscow can exploit to create a crisis situation.   In the short run, it is likely that Moscow is calculating that it can influence the Ukrainian presidential election in a way that advances its interest without risking a more dangerous confrontation.  But that is a very dangerous game that could well spin out of control.  With the boneless wonders in Brussels; Merkel at the Russians’ feet, and Berlusconi and Sarkozy not far behind; and a US administration dreaming of reset and distracted by Afghanistan and the health care imbroglio; an aggressive Russia looking back on the experience of the Georgia War may well be emboldened to taking the next big step in its ambition to restore a simulacrum of the Russian Empire.

August 17, 2009

Hacked Off

Filed under: Military,Politics — The Professor @ 9:54 pm

Russia “earned” five of the top world stories in the banner on today’s WSJ, and what a list it is.  The Arctic Sea fiasco.  The eleven-fatality accident at the  Sayano- Shushenskaya power plant.  A mass bombing in Ingushetia. And two stories relating to massive cybercrime.

The first involves the indictment of an American who was a participant in a plot to steal 130 million credit and debit cards.  With him were indicted, you guessed it, two Russians:

Subsequent investigations into breaches at Heartland and others led investigators back to Mr. Gonzalez. They found that he and his co-conspirators in Russia, which the indictment does not name, staged their crime on a network of computers spanning New Jersey, California, Illinois, Latvia, the Netherlands and Ukraine that would infiltrate the computer networks of the victim companies.

But to me this is the more interesting story:

Russian hackers hijacked American identities and U.S. software tools and used them in an attack on Georgian government Web sites during the war between Russia and Georgia last year, according to new research to be released Monday by a nonprofit U.S. group.

In addition to refashioning common  Microsoft Corp. software into a cyber-weapon, hackers collaborated on popular U.S.-based social-networking sites, including Twitter and Facebook Inc., to coordinate attacks on Georgian sites, the U.S. Cyber Consequences Unit found. While the cyberattacks on Georgia were examined shortly after the events last year, these U.S. connections weren’t previously known.

The research shows how cyber-warfare has outpaced military and international agreements, which don’t take into account the possibility of American resources and civilian technology being turned into weapons.

And just what is the Russian government doing about such massive cybercrime?  Well, the author of this research suggests that they are cooperating with it, and arguably exploiting it:

The Georgian attacks, according to the group’s findings, were perpetrated by Russian criminal groups and had no clear link to the Russian government. However, the timing of the attacks, just hours after the Russian military incursion began, suggests the Russian government may have at least indirectly coordinated with the cyberattackers, Mr. Bumgarner’s report concluded.

Note that the targets for the attack had to have been previously identified, and their vulnerabilities detected.  This doesn’t happen in hours.  Moreover, these targets were not likely to have been the kind of lucrative ones that would attract the interest of cyberthugs (like the ones in the first article, who had a scheme called “Get Rich or Die Tryin’.”)  Indeed, the criminals compromised very valuable assets–a huge botnet network and new hacking strategies–so it was costly for them, rather than directly profitable.  And the attack was almost simultaneous with the more traditional armored assault through the Roki Tunnel.  Put it all together, and there is a strong circumstantial case that the criminals who executed the Georgia hack were acting at behest of the Russian government and military, and that the attack had been planned well in advance (which also speaks to the ultimate responsibility for the start of the war).  It is difficult to think of a credible alternative explanation.  A spontaneous burst of patriotism from hardened criminals executed in record time doesn’t pass the smell test.

Add to this the disinterest in, and at times active resistance to, international efforts to attack in a serious way Russian cybercrime, and a more disturbing possibility emerges.  Namely, that there is a coincidence of interests between the government and cybercriminals.  The government allows them to operate with near impunity, and obtains a valuable strategic asset in return.  Perhaps elements in the government get a piece of the action too.

This has gone way, way beyond the point where this can be treated as a mere criminal matter.  The scope of the crimes–such as tens of millions of stolen identities in the Gonzalez-Russian scam–is too large, and the national security implications too grave.  Instead, the administration should pressure Russia hard, extremely hard, and at the highest levels, to take serious action to attack this problem in a systematic way.  If the government does this, all for the good.  If it doesn’t–and I would place good odds on this possibility–we will know that it is at least an accessory to this massive criminality, and more likely a co-conspirator.

August 15, 2009

It’s So Romantic

Filed under: Politics,Russia — The Professor @ 2:02 pm

I’ve written before on how Russia strikes me as a very Romantic country.  Not in the look-into-my-eyes-darling sense of the word, but in the more philosophical sense of the word (note the capitalization).  That thought struck with particular force as I began to read Peter Viereck’s Metapolitics: From Wagner and the German Romantics to Hitler.  Many of the Romantic strains that Viereck identifies in German history and character types are also pronounced in Russia.  Indeed, take virtually any one of the quotes to follow, and you can replace “German” with “Russian” and still strike very close to the bone.

First, a Nietzsche quote in Viereck:

The Germans think that strength must reveal itself in hardness and cruelty; then they submit with fervor and admiration; they are suddenly rid of their pitiful weakness and their sensitivity over trifles, and they devoutly enjoy their terror.  That there is strength in mildness and stillness, they do not believe easily.

Here’s Viereck himself:

Almost every major German figure bears within himself both sides of this contrast [between the Romanized German and the Saxon].  That is why German thinkers and bards talk more of “two souls in one breast” than do the thinkers of any national culture.  . . . They treat their souls as a fond mother treats an enfant terrible: scolding yet egging on.  That may make them “geniuses” and “daemonic,” but this inner conflict over the Roman wall is not always so harmless.  Sometimes it is psychologically accompanied by projection, fanaticism, hysteria, instability, delusions of persecution plus persecution of others, and convulsive outbursts of physical violence.

That last sentence really hits the mark.

This next quote resonates given Russian arguments about its victimization at the hands of invaders over the centuries:

Indeed, throughout history Germany can argue an excellent case against the west.  Tact and peaceful reasoning were not conspicuous in the invasions of Germany. . . . But this admission does not invalidate our thesis that Germany’s aggressive inferiority complex against western civilization is the greatest cultural and political tragedy of Europe.

Here Viereck quotes Gustav Pauli:

Romanticism is Germanic and reached its purest expression in those territories which are freest from Roman colonization.  Everything that is regarded as an essential aspect of the romantic spirit, irrationalism, the mystic welding together of subject and object, the tendency to intermingle the arts, the longing for the far-away and the strange, the feeling for the infinite and the continuity of historic development.

I found the phrase about “mystic welding together of subject and object” in particular to be a good characterization of Russians as well.

Here’s Viereck again:

Romanticism is really the nineteenth century’s version of the perennial German revolt against the western heritage.

Here’s a really good, though extended, passage that fits quite well:

Some readers may object that the stress on schizoid polarity in German minds, on inner swings of the pendulum, is inconsistent with stress on the German craving for discipline, authority, ruthless order.  But is it inconsistent?  Is not, rather, the excessive and traditional discipline by the German state the direct product of the excessive lack of inner discipline of the individual German?  In Germany as in America the increase in centralization of state power is the process by which the state is sucked into the vacuum created by the default in responsibility of the individual citizen.  Anarchy and tyranny are merely the opposite faces of a single coin.

. . . .

Germans accepted authoritarian Prussianism so enthusiastically precisely because it was so un-German  They accepted it as the opposite extreme, the needed overcompensation, of what they unconsciously sensed as their most dangerous and typical quality: their intoxication with chaos, their Faustian romanticism.

But even in this reaction Germans could not escape themselves.  In fact, nothing is more typical of the chaotic romantic temperament than this very attempt to escape from itself into the prison of limitless authoritarianism.

Germans have a strange habit of fleeing not from prisons but into prisons.

. . . .

The masses worship a prison-camp type of state with fanatic hysteria so long as it saves each of them, as romantic individuals, from his inner mental and emotional anarchy.

The juxtaposition of extreme anarchic and extreme authoritarian tendencies is well-remarked in Russia.  Indeed, to this very day many defenders of the current system invoke fears of the former to justify the latter.

Here’s some interesting pieces on the statist impulse:

[Quoting Novalis} “From each true state-citizen grows forth the soul of the state, just as in a religious community a single personal God manifests Himself as if in thousands of shapes.”  Novalis defines each citizen as a mere “limb” of the state organism, which is “alive and personal.”

. . . .

The organic view was valuable in unifying so loose a federation as the Germany of the eighteenth century and of the pre-Bismarck nineteenth century.  Such an all too “atomistic” Germany was, we must remember, the historical context of the romantic revolt against atomism.

. . . .

The self-justified state, like the Faustian man, must not let ethical discrimination hamper its experience of life’s totality.  So we are not surprised to find Adam Muller end with bloody hymns to war.  The result of Hegel’s state-worship too, was that the state became the ethical end in itself in much influential German political thought.  All individuals, all the external restrictions of international morality, and all the concretely existing internal parts of the state must be sacrificed to its mathematically non-existent who, the sum that is greater than its parts.

Statism, the state idolatry, the personification of the state, the submergence of the individual in the collective, the view that the state is the highest representation of the collective, are all quite pronounced in Russia too.  Russians too seem to flee to prisons rather from them, and seem think that on the whole it’s a good thing.

There’s a lot more, but these selections make the point.  I’d also point out that the virulent anti-Americanism (and anti-Semitism) that characterized German Romantic thought echoes strongly in Russia today, and for much the same reason.

Following on Pauli, Viereck hypothesizes that German Romanticism was the product of the division of Germany between the Latinized West and the Barbarian East.  That Germany was on the divide between two civilizations with wildly different mental and moral universes.  Romanticism was a revolt of the East against the West.

Russia, too, has a very uneasy, conflicted relationship with the Latinized West.  Indeed, although the dividing line did not run directly through Russia, as it did Germany (thanks to Hermann/Arminius), post-Peter I’s introduction of Western ideas into Muscovy, the same conflict has rent Russia, with many of the same consequences, political and psychological.  The Slavophiles and latterly, the Eurasianists (new and old), are in essence Russia’s indigenous Romantics.  (It is well known that German Romanticism was quite influential in Russia.  I think that this is primarily a matter that the doctrine found very fertile soil waiting for it there.)

In brief, Russia’s conflicted relationship with the West, and the psychological complexes associated therewith, bear uncanny similarities to Germany’s.  Both Germany and Russia lie on civilizational fault lines, and Russia and the non-Romanized parts of Germany were not all that dissimilar in terms of economy and social organization.  It should not be too surprising that each reacted similarly to the onslaught of modernity and the hegemony of the Latinized West, though each of course exhibits its own distinct characteristics.

Harking back to a post On Russophobia from almost exactly a year ago (and one which arguably had the biggest impact on the trajectory of SWP), it seems to me that my attitudes towards Russia are strongly reflective of my attitudes towards Romanticism.  I am decidedly un-Romantic, and indeed, think that Romanticism was an almost entirely pernicious doctrine.  Indeed, when I consider many of the political, cultural, and social phenomenon or viewpoints that I find the most objectionable, the thing that they are most likely to have in common is an explicit or implicit Romantic tie.  Hence, it is not surprising that I find much not to admire in Russian society, culture, and polity.  And as I said in On Russophobia, self-styled Russophiles, or Slavophiles, or Eurasianists would agree wholeheartedly with many of my characterizations of the features of Russian life and mind, but celebrate them, whereas I do not.

This disagreement Romanticism is characteristic of classical liberals.  I note with interest that in her Bourgeois Virutes, Deirdre (nee Donald) McCloskey, a more ardent classical liberal/libertarian than even I, repeatedly traces the horrors of the 20th century large and small to the baleful influence of the German Romantic school, and intends that the third volume of the proposed trilogy will set out her case in detail.  Viewed in this way, the debate over Russia is merely another manifestation of a longstanding philosophical conflict that has raged for a very long time, and in very many places.

So, from here on out: Don’t call me a Russophobe.  Call me a Romantiphobe;-)

Update:  Reading Viereck’s introduction to the last (2003) edition, I came across this sentence:

The same context is true of Slavophilism (imitated from the German romantic’s [sic] by the Aksakov Brothers) and the Arab Volk mystique.  Had I but world enough and time (at 86), I’d have expanded Metapolitics to enable me to add to its subtitle: “From the German Romantics to Russians and Arabs.”

So, I guess the late Dr. Viereck would have agreed with the essence of my analysis.

An Historic Moment

Filed under: Climate Change,Economics,Politics — The Professor @ 9:33 am

In my post-election quasi-rant, I considered the possibility that the worse, the better:  that it would be better in the end for liberty and more limited government if Obama and the Congressional Democrats indulged the wildest policy fantasies in health care, climate change, and domestic government spending.  I conjectured that this would set off a popular reaction that would derail these endeavors.

The first part of the scenario has definitely played out.  Indeed, Obama, by delegating his agenda to the almost uniformly leftist leadership of Congress, and exploiting the financial crisis and sharp recession, has pursued a far more thoroughgoing attempt to reshape America than I thought possible even in my gloomiest moments.

And now there are clear indications that the second part of the scenario is playing out as well. The tumults at Congressional townhalls in particular are the most palpable evidence of this, but that is only the tip of the iceberg.

Much of this opposition is inarticulate at best, and at the fringes degenerates into sputtering and at times ugly rage.  But it is genuine.

And the coastal elites are by no means pleased.  (It is ironic, isn’t it, that leftists praise anger and rage as evidence of authenticity–except when it is directed at them?)  The divide over health care in particular, and to a slightly lesser degree cap & trade, is just another manifestation of the same cultural schism that makes figures like Sarah Palin so divisive.

For government-dominated health care (and the rest of the Obama agenda) is an elite project; progressivism (and Progressivism) has always been elitist, and more than willing to coerce the great unwashed into doing what their betters know is good for them.  It looks to Europe for its inspiration, and is dismissive of distinctively American institutions, and of the vision of the Founders in particular.

But Americans have the infuriating habit of not being Europeans.  They are far less deferential to authority, and to the authority of self-styled elites in particular.  European society is far-less open access than the US; just consider the dominance of the graduates of a few elite schools in French government.  Consequently, the elites have a much rougher time getting their way here, than in Europe.

We are at a historical moment.  In my post-election post, I shrunk from hoping for the worse-the-better because I feared that the US had become sufficiently Europeanized that the agenda would be implemented, at the eternal cost of our liberties and future prosperity.  The coming couple of months–most notably, the period of the Congressional recess and the first weeks after its return–will be decisive.

The tragedy is that the organized (and I use that term very loosely) political opposition, the Republican Party, is leaderless, clueless, and itself far too complicit in the statist project to provide a compelling and constructive alternative.  As a result, the current opposition, energetic as it is, is also inchoate and likely to dissipate as soon as this round of the health care and cap & trade debates ends.  Meaning that even if this battle is won, the statist elites will be back.

August 14, 2009

Clear as Mud

Filed under: Commodities,Derivatives,Economics,Energy,Exchanges,Financial crisis,Politics — The Professor @ 2:37 pm

The Treasury Department has released its draft OTC derivatives regulation bill, “The Improvements to Regulation of Over-the-Counter Derivatives Act.”  The actual language of the 115 page proposal follows quite closely what Geithner has been floating for several months–a clearing mandate for standardized derivatives, attempts to force OTC derivatives trading onto execution facilities, differential margin and capital requirements for cleared and non-cleared products.

My initial reactions:

First, there’s a whole lot of delegatin’ goin’ on.  A good part of the bill sets out the haziest general objectives, and then directs the CFTC, SEC, and “the Prudential Regulator” (either the Fed, the Office of the Comptroller of the Currency, or the FDIC, depending on a bank’s charter status) to come up with specific rules on what constitutes a standardized derivative, capital and margin requirements, position limits and so on.  There is an aggressive timeline for most of these rules–180 days.  Given the depth and breadth of the issues, and their contentious nature, and the needs to coordinate among disparate agencies, this will be very difficult to do at all, and extremely difficult to do well.

Second, the Treasury has finessed the jurisdictional issues by giving multiple regulators authority over OTC derivatives markets, with the injunction that everybody share and play well together.  Many of the provisions require that the CFTC and SEC issue rules jointly, with the proviso that if they cannot, the Treasury will prescribe them.

Given the delegation-heavy aspect of the proposal, there are few specifics to analyze.  But there are some aspects of the proposed bill that are spelled out with sufficient detail that deserve comment.

I’ve beaten the clearing mandate horse repeatedly before, so I won’t do more than repeat my previous conclusion that the mandate approach is wrongheaded, and ignores crucial economic issues.  The proposal does not require clearing when “one of the counterparties to the swap— (i) is not a swap dealer or major swap participant; and  (ii) does not meet the eligibility requirements of any derivatives  clearing organization that clears the swap.”  This would seem to permit an end user (e.g., a gas producer) to enter into a swap with a dealer without triggering the clearing mandate.

This is a desirable feature, and would permit end-users to enter into swaps without having to clear them; this could be especially important for end users concerned about the cash flow and liquidity risks associated with daily mark-to-market.  However, there are some peculiarities as to what constitutes a swap dealer or major swap participant that confuse me, and create ambiguity in the application of this exemption from the clearing requirement.  For instance:

The term ‘swap dealer’ means any person engaged in  the business of buying and selling swaps for such person’s own account, through a  broker or otherwise.

“(B) EXCEPTION.—The term ‘swap dealer’ does not include a person that  buys or sells swaps for such person’s own account, either individually or in a  fiduciary capacity, but not as a part of a regular business.”

“As part of a regular business”?  As opposed to what?  An irregular business?  A hobby?  I think most involved in this industry have a pretty good idea of what a swap dealer is, but would have a hard time recognizing one from the language just quoted.  A dealer is a firm that stands willing to quote prices at which it is willing to buy and sell products–a market maker.   The dealers/market makers usually enter into large numbers of off-setting positions.  Those features are totally absent from the bill’s definition of dealer.

Here’s the definition of a “major swap participant”:

The term ‘major swap participant’ means any  person who is not a swap dealer and who maintains a substantial net position in  outstanding swaps, other than to create and maintain an effective hedge under generally  accepted accounting principles, as the Commission and the Securities and Exchange  Commission may further jointly define by rule or regulation.

It seems the key phrases here are “substantial net position” for a purpose “other than to create and maintain an effective hedge.”  So, they’re not hedgers, and they have a substantial net position.  The addition of the “net position” language would seem to mean that swap dealers often don’t have net positions, which is true.

So, it would seem that what Treasury is trying to say is that a major swap participant is not a dealer and not a hedger, so that would suggest speculator.  But what about a hedge fund that is basis trading, or spreading between some cash instrument or commodity and a derivative?  A lot of speculators do just that.  Are they hedgers?  You could argue that the derivative is hedging the cash position, and under that interpretation any deal involving a hedge fund engaging in this strategy would be exempt from the clearing mandate.  I doubt that’s what Treasury means, but their drafting leaves a lot to be desired.  This imprecision will become a litigation magnet if it makes its way into law.

This is true not just because the clearing mandate turns on the classification of the counterparties, but because the execution facility mandate does so as well:

Except as provided in paragraph (8), a swap that is  standardized shall be traded on a board of trade designated as a contract market under  section 5 or on an alternative swap execution facility registered under section 5h.

“(8) EXCEPTIONS.—The requirements of subsection (j)(1) and (7) do not apply to  a swap if—  “(A) no derivatives clearing organization registered under this Act will  accept the swap for clearing; or

“(B) one of the counterparties to the swap—

“(i) is not a swap dealer or major swap participant; and

“(ii) does not meet the eligibility requirements of any derivatives  clearing organization that clears the swap.”.

So, if our hypothetical hedge fund doing a basis trade is deemed a hedger, any trade it does needn’t be executed on an alternative swap execution system (e.g., an electronic trading platform) that is subject to various requirements and obligations similar to those imposed on exchanges.

This whole regulatory schema is based on creating distinct classes of market participants, with different rights and obligations.  Given that the mandates in the proposal turn on the classifications of both parties to a trade, and that there is notable ambiguity in the definitions of the classifications, this will likely lead to some legal disputes.

The proposal also addresses the “standardization” issue, but again in an unsatisfactory way.  This is also crucial because the clearing and trading mandates also turn on standardization.  Most of the specifics are punted to CFTC and SEC, but the proposal does set out some criteria that the agencies should take into consideration when determining whether something is standardized.  These criteria include whether trade terms (including prices) are distributed, or relied on in determining the prices of other deals, and the volume of trade.  Unfortunately, however, most of the other criteria refer to the “terms” of the swap as the criteria by which CFTC and SEC assess standardization.  Are the terms of swap A like those of swap B that is cleared?  Are the differences in terms economically significant?

But it’s not just the terms that matter in determining suitability for clearing.  The risk characteristics of the instrument, and the availability of pricing information are also relevant.  Two deals with very similar terms may differ along these economic dimensions in ways that make one efficient to clear, and the other not.  (The volume of trading requirement is a crude way of assessing the price information availability issue.)  Moreover, these economically relevant factors may vary over time.  Is a CFTC/SEC determination permanent?  This would be problematic.  It should also be noted that due to economic differences, and variations of these economic conditions over time, that clearinghouses may not price risks appropriately, and that as a result the mandate could discourage mutually beneficial trades that parties would be willing to enter bilaterally because it is cheaper to do that than to clear.

The proposal also sets out rules for capital requirements and margins on non-cleared deals, but these aren’t that helpful:

BANK SWAP DEALERS AND MAJOR SWAP PARTICIPANTS.—In setting  capital requirements under this subsection, the Prudential Regulators shall  impose:

“(i) a capital requirement that is greater than zero for swaps that  are cleared by a derivatives clearing organization; and

“(ii) to offset the greater risk to the swap dealer or major swap  participant and to the financial system arising from the use of swaps that  are not centrally cleared, higher capital requirements for swaps that are not  cleared by a registered derivatives clearing organization than for swaps  that are centrally cleared.

“(B) NONBANK SWAP DEALERS AND MAJOR SWAP PARTICIPANTS.—Capital  requirements set by the Commission and the Securities and Exchange  Commission under this subsection shall be as strict as or stricter than the capital  requirements set by the Prudential Regulators under this subsection.

So, capital requirements on cleared deals are positive, and requirements on cleared deals are higher than that.  That’s a huge help, guys.  This will touch off huge efforts to influence the determination of these requirements, and regulators will quite honestly not have the knowledge or information to set them efficiently.  I foresee reliance on crude proxies for risk, such as . . . wait for it . . . credit ratings.  Heaven help us.

Margin requirements are similarly fuzzy:

Prudential Regulators shall impose both initial and variation margin requirements  under this subsection on all swaps that are not cleared by a registered derivatives  clearing organization, except that the Prudential Regulators may, but are not  required to, impose margin requirements with respect to swaps in which one of  the counterparties is—

“(i) neither a swap dealer, major swap participant, security-based  swap dealer nor a major security-based swap participant;

“(ii) using the swap as part of an effective hedge under generally  accepted accounting principles; and

“(iii) predominantly engaged in activities that are not financial in  nature, as defined in section 4(k) of the Bank Holding Company Act of  1956 (12 U.S.C. 1843(k)).

“(B) NONBANK SWAP DEALERS AND MAJOR SWAP PARTICIPANTS.—Margin  requirements for swaps set by the Commission and the Securities and Exchange  Commission under this subsection shall be as strict as or stricter than margin  requirements for swaps set by the Prudential Regulators.

So, again: virtually no guidance on the principles regulators shall use to set margins, the counterparty classification issue, and the need to get numerous regulators to play nicely.

The proposal also opens the way for the vast expansion of position limits.  Swap execution facilities are required to set accountability or position limits, which means that the reach of these limits is extended to the swap market.  Moreover, Section 723 states:

The Commission may, by rule or regulation,  establish limits (including related hedge exemption provisions) on the aggregate number  or amount of positions in contracts based upon the same underlying commodity (as  defined by the Commission) that may be held by any person, including any group or class  of traders, for each month across—

“(A) contracts listed by designated contract markets;

“(B) contracts traded on a foreign board of trade that provides members or  other participants located in the United States with direct access to its electronic  trading and order matching system; and

“(C) swap contracts that perform or affect a significant price discovery  function with respect to regulated markets.

The definition of “significant price discovery function” is very broad:

SIGNIFICANT PRICE DISCOVERY FUNCTION.—In making a determination  whether a swap performs or affects a significant price discovery function with respect to  regulated markets, the Commission shall consider, as appropriate:

“(A) PRICE LINKAGE.—The extent to which the swap uses or otherwise  relies on a daily or final settlement price, or other major price parameter, of  another contract traded on a regulated market based upon the same underlying  commodity, to value a position, transfer or convert a position, financially settle a  position, or close out a position;

“(B) ARBITRAGE.—The extent to which the price for the swap is  sufficiently related to the price of another contract traded on a regulated market  based upon the same underlying commodity so as to permit market participants to  effectively arbitrage between the markets by simultaneously maintaining positions  or executing trades in the swaps on a frequent and recurring basis;

“(C) MATERIAL PRICE REFERENCE.—The extent to which, on a frequent  and recurring basis, bids, offers, or transactions in a contract traded on a regulated  market are directly based on, or are determined by referencing, the price  generated by the swap;

“(D) MATERIAL LIQUIDITY.—The extent to which the volume of swaps  being traded in the commodity is sufficient to have a material effect on another  contract traded on a regulated market;

These criteria would apply to most important, heavily traded OTC products.  Thus, the bill would give the CFTC tremendous power to impose position limits on combined OTC and exchange-traded positions.  Given the contentiousness of the position limit issue in energy alone, one can only imagine the difficulties that await when the CFTC’s powers to set limits extend to everything.

Overall, I think that it is a travesty to call this the “Improvements to regulation” act.  All of the substantive elements–the clearing mandate, the trading mandate, the setting of capital and margin requirements by relatively uninformed regulators subject to influence and pressure, the position limits–have no solid economic justification.  Indeed, the stronger justifications cut the other way in virtually every case.  Moreover, the ambiguities in the definition of key terms that determine the reach of the mandates are a recipe for trouble later on.  The delegation of virtually all implementation details to regulators, the rapid time frame for the formulation of specific rules, the need for coordination across regulators, and the lack of anything more than the haziest guidance will create immense implementation problems and lead to enormous influence activities.

All in all, therefore, this would be better titled “The (further) Bollixing of the Regulation of Over-the-Counter Derivatives Act.”

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